INDIAN FINANCIAL SYSTEM

The financial market across the globe is changing at unprecedented pace. The
international financial markets are striving to be swift and superefficient by absorbing
all available technologies and knowhow. In the Indian scene, the market lags behind
in many crucial areas especially in technology and innovation very much appropriate
to our cultural ethos.
Market – Meaning and definitions
Propelled by the pressures of demand and supply, regular exchange of goods and
services for a price can create a market. Generally, a market comes in to existence
with the following ingredients:
a. A location which may be an area accommodate people desirous of buying and
selling. The location need not be a particular place; it may be local, regional,
national or international.
b. A large number of sellers; ie. producers and suppliers of goods and services or
their agents who aims profit.
c. A large number of sellers, who make use of the utility value of goods and
services bought.
d. The wares/goods; ie. goods and services are traded in the market.
e. The supply of social amenities like transportation, banking, insurance etc.
Capital Market
The capital market is concerned with long term finance which facilitates the allocation
of funds between savers and users. It operates as a switching mechanism for transfer
of funds to meet the long term needs of private and public enterprises. Thus the
lenders and borrowers of the long term capital and their intermediation through a
‘fund vehicle’ (stock exchange) for transfer, on a regular basis create the capital
market.
A capital market deals in financial services and claims or financial assets or securities
or financial instruments of long term nature. These services and claims are many and
varied in nature. This is so because of the diversity of motives behind borrowing and
lending.
Capital market is an organized market mechanism for effective and efficient transfer of
money capital or financial resources from the investing class to the entrepreneur class
in the private and public sectors of the economy.
H. T. Parikh states, ‘By capital market I mean the market for all financial instruments,
short-term and long-term as also commercial, industrial and government papers’.
According to IM Pandey, “Capital Markets deal in securities. Capital market facilitates
the allocation of funds between savers and borrowers”.
A security in one sense, is a document or certificate in evidence of loan (in case of
bonds/deposits) or supply of capital in some other form (as in the case of shares). In
another sense, security is a thing deposited/pledged as guarantee fulfillment of some
undertaking or payment of loan, which can be forfeited in case of failure. It is
interesting to note that the security in the former sense can be used as security in the
latter sense.
Characteristics of a capital market
 Deals in long term and medium term funds. These funds are locked up for a
period exceeding one year.
 It trades in funds both securitized and non-securitized. Securitized funds are
equity shares, preference shares, convertible debentures, non convertible
 debentures, public sector bonds, saving certificates, guilt-edged securities etc.
The non-securitized funds are not represented by a security in general sense,
eg: bank deposits, company fixed deposits, provident fund scheme, life
insurance etc.
 It directs the flow of funds from undesirable sectors to sectors of national
importance which can create infrastructure for development.
 The securities traded in the capital market are transferable and thus
marketable. Hence it provides liquidity to investment.
 The dealers in the market who have sound financial positions and knowledge
about the operations in the market bring competency and efficiency in their
dealings.
 Generally the capital market is regulated by government of the country which
brings about discipline and transparency in dealings of the market.
 A capital market is very sensitive or volatile to many internal and external
factors. A good agricultural production, monsoon, government policy, war,
natural calamities etc can bring immediate cyclical changes in the security
prices of the market.
 The state of the capital market is an indicator of corporate performance in a
country.
Objectives of Capital Market:
In 1955, the then Finance Minister spoke about the objectives of the capital and
securities market in the Lok Sabha in this way:
The economic services which a well regulated and efficiently run capital market can
render to a country with a large private sector are considerable.
In the first place, it is only an organized securities market (an integral part of capital
market) which can provide sufficient marketability and price continuity for shares, so
necessary for the needs of investors.
Secondly, it is only such a market that can provide a reasonable measure of safety and
fair dealing in the buying and selling of securities.
Thirdly, through the interplay of demand for and supply of securities, properly
organized stock exchange assists in a reasonably correct evaluation of securities in
terms of their real worth.
Lastly, through such evaluation of securities the stock exchange helps in the orderly
flow and distribution of savings as between different types of competitive investments.
Importance of Capital Market
1. It is only with the help of capital market, long-term funds are raised by the business
community.
2. It provides opportunity for the public to invest their savings in attractive securities
which provide a higher return.
3. A well developed capital market is capable of attracting funds even from foreign
country. Thus, foreign capital flows into the country through foreign investments.
4. Capital market provides an opportunity for the investing public to know the trend of
different securities and the conditions prevailing in the economy.
5. It enables the country to achieve economic growth as capital formation is promoted
through the capital market.
6. Existing companies, because of their performance will be able to expand their
industries and also go in for diversification of business due to the capital market.
7. Capital market is the barometer of the economy by which you are able to study the
economic conditions of the country and it enables the government to take suitable
action.
8. Through the Press and different media, the public are informed about the prices of
different securities. This enables the public to take necessary investment decisions.
9. Capital market provides opportunities for different institutions such as commercial
banks, mutual funds, investment trust; etc., to earn a good return on the investing
funds. They employ financial experts who are able to predict the changes in the
market and accordingly undertake suitable portfolio investments.
10. It acts as a mirror of the general economic conditions of the nation reflecting phase
of business cycles.
11. It prevents accumulation of wealth in the hands of a few by ensuring wide spread
of distribution of securities.
12. It ensures public participation in the nation’s industrialization process.
13. It provides a mechanism for transfer of securities.
Functions of capital market
 Capital market helps in capital formation:- Capital formation and promotion
of investment are two important functions of capital market. The savings in the
country should be converted into productive capital. In the absence of capital
market, the vital resources, ie., savings of the community become idle.
 Helps the entrepreneurs to tap resources:- Huge investment and monitoring
is required to build strong infrastructure which can provide high-tech
production. It requires huge amount of capital which can’t be raised from a few
individuals. A large number of individuals having investible surplus is required
for the same. A capital market can make it by acting as a facilitator between the
savers and entrepreneurs to make available required resources by floating of
mega issues of shares and debentures.
 Helps in selection of an ideal investment portfolio which maximize return
and minimize risk:- The investors in the capital market may be risk averters or
risk lovers. Risk averters prefer investments which bring steady and assured
returns regularly (debentures, preference shares etc). Risk lovers prefer in
projects which brings hefty returns which is uncertain. The capital market
deals in such variety of diversified financial instruments to meet varied needs of
the investors and helps to build a suitable investment portfolio. [The set of all
securities held by an investor is called portfolio. It is the proportion of stocks
(equity shares and units/shares of equity oriented MFs) and bonds (fixed
income investment vehicle in general) in the portfolio. The appropriate stock-
bond mix depends on the risk tolerance and investment horizon of the investor.
Risk may be business risk, inflation risk, interest rate risk and market risk].
 Helps in financial innovation and development:- Financial innovation means
introduction of a new financial instrument or service or introducing new uses of
funds or finding out new sources of funds. The financial innovation emphasizes
growth, income, tax shield, liquidity, convertibility, safety and security of
investment. Capital market which paves the way for financial innovation.
 Helps in integrating different components of financial system:- The capital
market establishes close connection or effective linkage between different parts
of the financial system. These parts and sub parts are the new issue market,
stock exchange, money market, foreign exchange market, bullion market etc.
 this will helps to bring about a uniform flow of financial information and
‘information arbitrage efficiency’ in the market.
 Helps in maintaining a steady market and liquidity to investment:- The
stock exchange (one of the constituents of capital market) has helped to
maintain a steady market and liquidity to investment. Liquidity means the
ability of the investment to be turned into cash or near cash without loss of
time and value. Since securities can be bought and sold in the stock market
and investor can switch on from one investment to another very easily and
quickly.
 Helps speculation and brings buoyancy in trading activities of the stock
market:- speculation refers to the buying and selling of assets and securities
with the expectation that the price will increase or decrease in future.
Speculators who trade within the boundary of their wealth don’t harm to the
market mechanism. They give extra facilities to the trading activities in the
secondary market.
 Helps in the economic growth and development of a country:- Modern
economies are characterized by: a) the ever expanding nature of business
organizations, b) the ever increasing scale of production, c) the separation of
savers and investors, d) the differences in the attitude of savers and investors.
In these conditions it is necessary to connect the savers and investors. The
capital market helps to establish a bridge between savers and investors and to
help the mobilization of savings and to convert the investment ideas into
realities.
Structure of Indian capital Market
The structure of Indian capital market can be better understood as segments which
are :
[Link] and Secondary Markets
[Link] and Unorganized Markets
[Link] and Non-institutional Dealer Markets
IV. Marketable and Non-marketable Securities Market
[Link] and Secondary Markets
[Link] Market/New Issue Market (NIM):-Primary market is where a company
makes its first contact with the public at large in search of capital. It is also called the
new issue market. It comprises not only the newly floated companies offering
securities to the public but also existing companies offering securities to the public.
The securities issued in primary market include equity shares, preference shares,
debentures, convertible securities, warrants, cumulative convertible preference shares,
zero coupon bonds and convertible warrants.
[Link] Market/Stock Market:- Secondary market comprises the buyers and
sellers of shares and debentures subsequent to the original issue. In secondary
market, one can buy and sell securities, whereas in primary market one can only
purchase securities. In secondary markets purchases and sales of securities issued by
government and semi government bodies and other public bodies and sharesand
debentures of joint stock companies are effected.
[Link] and Unorganized Markets
[Link] Market:- The organized markets have formally settled systematic
procedures and rules which are regulated by the Government or government agencies.
In the organized sector of capital markets demand for long term capital comes from
corporate enterprises, government and semi government enterprises requiring funds
for various developmental activities. The source of supply of funds comprises
individual investors, corporate and institutional investors like banks, investment
trusts, insurance companies, financial corporations, government and international
financial agencies.
[Link] Market:- The unorganized market is not subject to specific rules
and regulations. It consists of money lenders, land lords etc. who lend money to public
and indigenous banks who also accepts deposits from them. These are also private
finance companies, chit funds and host of other unincorporated bodies whose
activities are not subject to proper financial disciplines of the government.
[Link] and Non-institutional Dealers Market
[Link] Dealers:- The institutional dealers in the market can be broadly
classified into banking and non banking financial intermediaries(NBFI). NBFIs include
LIC, Mutual Funds, UTI, IDBI, ICICI etc. Apart from that foreign institutional investors
(FII) and Foreign Direct Investment (FDI) are two leading players in the institutional
dealers.
[Link]-Institutional Dealers:- They are primarily individuals, partnership firms,
households etc. dealing with primary and secondary markets with the help of a
broker/ underwriter/ banker for the buying and selling of securities.
[Link] and Non-Marketable Securities Market
[Link] Securities Market:- When long term fund requirements are
securitized into tradable form, a marketable securities market comes into existence.
The various sub markets of marketable securities market are: equity share market,
preference share market, debt market, public sector bond market, government
securities market, market for securities of local authorities and market for units of UTI
and other MF schemes. Of the above sub markets, equity share market is the most
prominent.
[Link]-Marketable securities market:- In the case of non-marketable securities,
they have no secondary market. These are non securitized financial investments which
are neither transferable nor negotiable. A non marketable investment can take the
following forms: bank FD, post office deposits and certificate, company fixed deposit,
inter corporate deposits, provident fund and pension fund schemes, national savings
schemes, life insurance policies etc.
Factors responsible for growth and development of capital market in India
1. Growth of Development Banks and Financial Institutions:-For providing
long term funds to industry, the government set up Industrial Finance
Corporation in India (IFCI) in 1948. This was followed by a number of other
development banks and institutions like the Industrial Credit and Investment
Corporation of India (ICICI) in 1955, Industrial Development Bank of India
(IDBI) in 1964, Industrial Reconstruction Corporation of India (IRCI) in 1971,
Foreign Investment Promotion Board in 1991, Over the Counter Exchange of
India (OTCEI) in 1992 etc. In 1969, 14 major commercial banks were
nationalized. Another 6 banks were nationalized in 1980. These financial
institutions and banks have contributed in widening and strengthening of
capital market in India.
2. Setting up of SEBI:- The Securities Exchange Board of India (SEBI) was set up
in 1988 and was given statutory recognition in 1992.
3. Increasing Awareness:- During the last few years there have been increasing
awareness of investment opportunities among the public. Business newspapers
and financial journals (The Economic Times, The Financial Express, Business
 India, Money etc.) have made the people aware of new long-term investment
opportunities in the security market.
4. Growing Public Confidence:- A large number of big corporations have shown
impressive growth. This has helped in building up the confidence of the public.
The small investors who were not interested to buy securities from the market
are now showing preference in favour of shares and debentures. As a result,
public issues of most of the good companies are now over-subscribed many
times.
5. Credit Rating Agencies:- Credit rating agencies provide guidance to investors /
creditors for determining the credit risk. The Credit Rating Information Services
of India Limited (CRISIL) was set up in 1988 and Investment Information and
Credit Rating Agency of India Ltd. (ICRA) was set up in 1991. These agencies
are likely to help the development of capital market in future.
6. Growth of Mutual Funds:- The mutual funds collects funds from public and
other investors and channelize them into corporate investment in the primary
and secondary markets. The first mutual fund set up in India was Unit Trust of
India in 1964.
7. Development of Venture Capital Funds:- Venture capital represents financial
investment in highly risky projects with a hope of earning high returns. After
1991, economic liberalization has made possible to provide medium and long
term funds to those firms, which find it difficult to raise funds from primary
markets and by way of loans from FIs and banks.
8. Growth of Multinationals (MNCs):- The MNCs require medium and long term
funds for setting up new projects or for expansion and modernization. For this
purpose, MNCs raise funds through loans from banks and FIs. Due to the
presence of MNCs, the capital market gets a boost.
9. Growth of Underwriting Business:- The growing underwriting business has
contributed significantly to the development of capital market.
10. Growth of Merchant Banking:- The credit for initiating merchant banking
services in India goes to Grindlays Bank in 1967, followed by Citibank in 1970.
Apart from capital issue management, merchant banking divisions provide a
number of other services including provision of consultancy services relating to
promotion of projects, corporate restructuring etc.
11. Growth of Entrepreneurs:- Since 1980s, there has been a remarkable growth
in the number of entrepreneurs. This created more demand for short term and
long term funds. FIs, banks and stock markets enable the entrepreneurs to
raise the required funds. This has led to the growth of capital market in India.
12. Legislative Measures:- The government passed the companies Act in 1956.
The Act gave powers to government to control and direct the development of the
corporate enterprises in the country. The capital Issues (control) Act was passed
in 1947 to regulate investment in different enterprises, prevent diversion of
funds to non-essential activities and to protect the interest of investors. The Act
was replaced in 1992.
Reforms in capital market since 1991
The government has taken several measures to develop capital market in post-reform
period, with which the capital market reached new heights. Some of the important
measures are
1. Dematerialisation of Shares:-Dematerialisation of shares has been introduced
in all the shares traded on the secondary stock markets as well as those issued
 to the public in the primary markets. Even bonds and debentures are allowed
in demat form. The advantage of demat trade is that it involves Paperless
trading.
2. Screen Based Trading:- The Indian stock exchanges were modernized in 90s,
with Computerized Screen Based Trading System (SBTS), It cuts down time,
cost, risk of error and fraud and there by leads to improved operational
efficiency. The trading system also provides complete online market information
through various inquiry facilities.
3. Establishment of Securities and Exchange Board Of India (SEBI):- SEBI
became operational since 1992. It was set with necessary powers to regulate the
activities connected with marketing of securities and investments in the stock
exchanges, merchant banking, portfolio management, stock brokers and others
in India. The objective of SEBI is to protect the interest of investors in primary
and secondary stock markets in the country.
4. Establishment of National Stock Exchange (NSE):- The setting up to NSE is a
landmark in Indian capital markets. At present, NSE is the largest stock market
in the country. Trading on NSE can be done throughout the country through
the network of satellite terminals. NSE has introduced inter-regional clearing
facilities.
5. Investor Protection:- The Central Government notified the establishment of
Investor Education and Protection Fund (IEPF) with effect from 1st Oct. 2001:
The IEPF shall be credited with amounts in unpaid dividend accounts of
companies, application moneys received by companies for allotment of any
securities and due for refund, matured deposits and debentures with
companies and interest accrued there on, if they have remained unclaimed and
unpaid for a period of seven years from the due date of payment. The IEPF will
be utilised for promotion of awareness amongst investors and protection of their
interests.
6. The National Securities Clearing Corporation Limited (NSCL):- The NSCL
was set up in 1996. It has started guaranteeing all trades in NSE since July
1996. The NSCL is responsible for post-trade activities of NSE. It has put in
place a comprehensive risk management system, which is constantly monitored
and upgraded to pre-expect market failures.
7. Trading In Central Government Securities:- In order to encourage wider
participation of all classes of investors, Including retail investors, across the
country, trading in government securities has been introduced from January
2003. Trading in government securities can be carried out through a
nationwide, anonymous, order-driver, screen-based trading system of stock
exchanges in the same way in which trading takes place in equities.
8. Credit Rating Agencies:- Various credit rating agencies such as Credit Rating
Information services of India Ltd. (CRISIL– 1988), Investment Information and
credit Rating Agency of India Ltd. (ICRA – 1991), etc. were set up to meet the
emerging needs of capital market. They also help merchant bankers, brokers,
regulatory authorities, etc. in discharging their functions related to debt issues.
9. Buy Back Of Shares:- Since 1999, companies are allowed to buy back of
shares. Through buy back, promoters reduce the floating equity stock in
market. Buy back of shares help companies to overcome the problem of hostile
takeover by rival firms and others.
10. Derivatives Trading:- Derivatives trading in equities started in June 2000. At
present, there are four equity derivative products in India Stock Futures, Stock
 Options, Index Futures, Index Options. Derivative trading is permitted on two
stock exchanges in India i.e. NSE and BSE. At present in India, derivatives
market turnover is more than cash market.
11. PAN Made Mandatory:- In order to strengthen the “Know your client" norms
and to have sound audit trail of transactions in securities market, PAN has
been made mandatory with effect from January 1, 2007.
12. Accessing Global Funds Market:- Indian companies are allowed to access
global finance market and benefit from the lower cost of funds. They have been
permitted to raise resources through issue of American Depository Receipts
(ADRs), Global Depository Receipts (GDRs), Foreign Currency Convertible
Bonds (FCCBs) and External Commercial Borrowings (ECBs). Further Indian
financial system is opened up for investments of foreign funds through Non-
Resident Indians (NRIs), Foreign Institutional investors (FIls), and Overseas
Corporate Bodies (OCBs).
13. Mutual Funds:- Mutual Funds are an important avenue through which
households participate in the securities market. As an investment intermediary,
mutual funds offer a variety of services / advantages to small investors. SEBI
has the authority to lay down guidelines and supervise and regulate the
working of mutual funds.
14. Internet Trading:- Trading on stock exchanges is allowed through internet,
investors can place orders with registered stock brokers through internet. This
enables the stock brokers to execute the orders at a greater pace.
15. Rolling Settlement:- Rolling settlement is an important measure to enhance
the efficiency and integrity of the securities market. Under rolling settlement all
trades executed on a trading day (T) are settled after certain days (N). This is
called T + N rolling settlement. Since April 1, 2002 trades are settled' under T +
3 rolling settlement. In April 2003, the trading cycle has been reduced to T + 2
days. The shortening of trading cycle has reduced undue speculation on stock
markets.
16. The Clearing Corporation Of India Limited (CCIL):- The CCIL was registered
in 2001, under the Companies Act, 1956 with the State Bank of India as the
Chief Promoter. The CCIL clears all transactions in government securities and
repos and also Rupee / US $ forex spot and forward deals. All trades in
government securities below Rs. 20 crores would be mandatorily settled
through CCIL, while those above Rs. 20 crores would have the option for
settlement through the RBI or CCIL.
Indian Financial System-Money Market and Capital Market
[Link] System
A financial system is a set of complex and closely connected or inter-mixed
institutions, agents, practices, market claims etc through which the appropriate
finance is made available. The financial system of a country comprises of the following.
-Financial Institutions
-Financial markets
-Financial instruments
-Financial services
I.1Financial Institutions
 Major pillars of financial system
 Mobilize/generate the savings of the country and provide various financial
services to the community
  Central bank controls, supervise and regulate financial institutions
 Types
a. Banking and non banking financial institutions
b. Intermediary and non intermediary financial institutions
c. Short term lending and long term lending financial institutions
d. Specialized and non-specialized financial institutions
e. Regional, national and international financial institutions
[Link] Markets
 Centres which facilitates buying and selling of financial instruments/ claims/
services
 Agents, brokers, dealers, borrowers, lenders etc. operate in a financial market.
The financial markets may be classified as:
a. Primary market and secondary market
b. Money market and capital market
c. Domestic market and foreign exchange market
d. Organized and unorganized market
e. Financial guarantee and mortgage market
[Link] Instruments
 The wares (goods) dealt in the financial markets are known as financial
instruments
 The savings of the community is transformed into various short term and long
term securities which are regularly traded in the market by financial
intermediaries and their agents.
[Link] Services
 Money transfer in the market will not become effective and meaningful without
financial services. The financial services are provided by provided by
professional in the market.
Classification of financial market
[Link] market:- Already explained
[Link] Market:- Money market is a short term market for money or near money
claims (close substitute for money), generally for a period up to one year. It provides a
mechanism for meeting the liquidity needs of the lenders and short term requirements
of borrowers with minimum delay. The objectives of money market are:-
a) To even out short term surplus or deficiencies of cash or near cash claims and
bring out equilibrium in the demand and supply of short term funds.
b) Money market is a focal point of the central bank through which the liquidity of
the economy is maintained by adopting appropriate monetary policies.
c) Short term requirements of funds are made available to the users of the market
with reasonable price/cost.
Besides the RBI, the leader of the market, a large number of commercial banks, both
scheduled and non-scheduled, co-operative banks, foreign exchange banks, DFHI,
LIC, GIC, UTI and large corporate are the major players of the money market. They
contribute the organized money market. The unorganized money market consists of
indigenous bankers, money lenders, nidhis, chit funds etc. operating without any clear
cut dividing line between short term and long term finance in their business.
Difference between money market and capital market
1. Money market is a market for short term funds normally up to one year
whereas the capital market is a market for long term funds.
 2. Money market is a source for working capital requirements whereas capital
market is source for fixed capital requirements. [but the same institutions in
both the markets]
3. The players in the money market are not individuals but institutions.
Individuals and institutions are the players in capital market. [As a
consequence, the volume of transactions in terms of rupee will be much higher
in money market as compared to capital market.
4. As institutions having professional hands for dealings in money market, it tends
to wholesale market. As there is individuals are also participating in a capital
market, it tends to be retail.
5. In money market, transactions are settled on ‘same day’ basis. Transactions in
certain types of securities may be carried forward in capital market.
6. The secondary market for money market instruments is negligible. But it is not
so in the case of capital market.
7. Money market provides required liquidity to the economy. Hence closure of
money market for a day can jeopardize the economy for want of liquidity. The
focus of the capital market is long term industrial growth. Closure of capital
market for a few days may not be immediately felt.
8. The money market is regulated by RBI whereas the capital market is regulated
by SEBI.
9. The main instruments traded in the capital market are equity shares,
debentures, bonds, preference shares etc. The money market instruments are
treasury bills, commercial bills, commercial papers, certificate of deposits etc.
10.A single investment in money market instruments involves huge sums of
money. But single investment in capital market does not require huge financial
outlays as the value of shares are generally low, Rs.10 or 100 or so.
[Link] regards returns and principal repayment, capital market instruments are
riskier than money market instruments.
[Link] of return on investment in capital market instruments is higher than
that of money market instruments as they are holding for a long period.
[Link] money market, transactions can be conducted without the help of brokers. In
capital markets, transactions can be conducted with the help of authorized
dealers only.
Characteristic features of a developed money market
Prof. [Link] has described certain essential features of a developed money market.
They are as follows:
1. Highly organized banking system:- The commercial banks are the central
nerve of the whole money market as it serve as a vital link between central bank
and various segments of money market. Hence a well developed money market
and highly organized banking system co-exist.
2. Presence of a central bank:- The central bank is the leader, guide and
controller of money market. The central bank enables the commercial banks
and other institutions to convert their assets into cash in times of financial
crisis. Through its open market operations, the central bank absorbs surplus
cash during off seasons and provides additional liquidity in the busy seasons.
3. Availability of proper credit instruments:- Availability of negotiable securities
such as bills of exchange, treasury bills etc and the presence of dealers and
brokers in large numbers to transact in these securities are needed for the
existence of a well developed money market.
 4. Existence of sub markets:- several sub markets together make a coherent
(ideal) money market. The larger the number of submarkets, the broader and
more developed will be the structure of money market.
5. Ample resources:- There must be sufficient funds to finance transactions in
the sub-markets. These funds may come from within the country (domestic
funds) and also from foreign countries (foreign funds).
6. Existence of secondary market:- There should be active secondary market in
these instruments.
7. Demand and supply of funds:-There should be large demand and supply of
short term domestic and foreign funds and should ensure adequate liquidity in
transactions.
8. Other factors:- other factors are:- rapid industrial development leading to the
emergence of stock exchanges, large volume of international trade leading to the
system of bills of exchange, political stability, favourable conditions for foreign
investments, price stabilization etc are the other factors which facilitates the
development of money market in a country.
Absence of one or more of these factors will lead to an underdeveloped money
market.
Importance of money market
A developed money market helps the smooth functioning of the financial system in any
economy in the following ways:
1. Development of trade and industry:- The money market, through discounting
operations and commercial papers (its instruments), finances short term
requirements of trade and industry both national and international.
2. Smooth functioning of commercial bank:- The money market helps the
commercial banks to employ their surplus funds in easily realizable assets and
ensures liquidity to their operations. It enables t meet their statutory
requirements of Cash Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR) by
utilizing money market mechanism.
3. Effective central bank control:- A developed money market helps the effective
functioning of a central bank. The central bank through the money market,
pumps new money into the economy in slump and siphons it off in boom. The
central bank thus regulates the flow of money so as to promote economic
growth with stability.
4. Development of capital market:- The short term rates of interest and the
conditions that prevail in the money market influence the long term interest as
well as the resource mobilization in capital market. Hence the development of
capital market depends upon the existence of a developed money market.
5. Formulation of suitable monetary policy:- conditions prevailing in a money
market is the true indicator of monetary state of an economy and guides the
government to formulate and revise monetary policy then and there.
6. Non-inflationary source of finance to Government:- A developed money
market helps the Government to raise funds through treasury bills instead of
printing and issue of more money and borrowing from the central bank and
hence decrease the inflationary trend in the economy.
Composition/sub-markets of Indian money market(organized structure)
I. The Call Money Market
It is the market for extremely short term period loans which varies from one
day/overnight (known as call money) to fourteen days (known as notice money).
These are repayable on demand at the option of either the lender or the borrower.
These loans are given for the following purposes:-
 To commercial banks for managing large payments and large remittances and
to maintain statutory liquidity requirements
 To stock brokers and speculators for dealing in stock exchanges and bullion
markets.
 To the bill market for meeting matured bills
 To the Discount and Finance House of India (DFHI) and Securities Trading
Corporation of India (STCI) to activate the call market.
 To individuals of very high status for trade purposes.
The operations in call money market are as follows:
 Borrowers and lenders negotiate over telephone to fix the amount of loan and
rate of interest. Hence it is basically an over-the telephone market. Once the
deal is fixed, the lender issues an FBL cheque and the borrower issues call
money borrowing receipt. After the repayment of loan, the lender returns the
duly discharged receipt.
 Instead of direct deal, it may be routed through DFHI. The borrowers and
lenders can inform the DFHI about the fund with them/fund required with
expected rate of interest. Once the deal is settled, a deal settlement advice is
exchanged. In case DFHI borrows, it issues a call deposit receipt to the lender
and receives RBI cheque for the money borrowed and the reverse will take place
if DFHI lends the amount to a borrower.
Call loans can be renewed up to a maximum period of 14 days only and such renewals
are recorded on the back of deposit receipt.
The participants in the call money market are those who permitted to act as borrowers
and lenders such as commercial banks, co-operative banks, DFHI and STCI and the
second one those who are permitted to act only as lenders in the market such as LIC,
UTI, GIC, IDBI, NABARD, specified mutual funds etc.
In India, commercial banks play a major role in the call money market. They used to
borrow and lend amount among themselves and such loans are called inter-bank
loans.
The advantages of call money markets are: it provides high liquidity, helps to maintain
statutory Liquidity Ratio for commercial banks, ensures high profit for lenders who
have surplus funds, safe investments as the participants have sound financial track
record and helps to fix monetary policies of RBI as it is highly liquid in nature.
Major draw backs are: [Link] India call money markets are located in developed
industrial centres like Mumbai, Calcutta, Ahmadabad, Delhi, Bangalore, Chennai etc
only, hence it is unevenly developed, b. call money markets in different centres are not
fully integrated, there are large number of local call money markets without any
integration, c. volatile nature of call money rate, which may vary between 12% to 85%
between different periods/seasons.
II. Commercial Bills Market or Discount Markets or market of bill of exchanges
A commercial bill is one which arises from short term credit trade. When goods are
sold on credit, the seller prepares (draws) a bill for the actual amount with the
condition to pay on a specified date and issues to the buyer and the buyer accepts it.
It is a ‘self liquidating’ and negotiable (transferable) paper for a short period ranging
from 3 to 6 months.
Sec.5 of the Negotiable Instruments Act defines a bill of exchange as, “an instrument
in writing containing an unconditional order, signed by the maker, directing a person
to pay a certain sum of money only to, or to the order of a certain person or to the
bearer of the instrument”.
Types of Bills
[Link] (sight) and Usance(time) Bills:- Demand bills are those bills which are to
be payable immediately after presenting the bill to the debtor/drawee/buyer. Usance
bills are payable after expiry of a specified time period.
[Link] Bills:-When bills are accompanied with documents of titles of goods
like bill of lading, railway/lorry receipt etc. the bills are called documentary bills.
[Link] against Acceptance (D/A) Bills:- When the documents titles of goods
accompanying a documentary bill are delivered to the drawee/trader/buyer
immediately after his acceptance of the bill, it is called a D/A bill.
[Link] against Payment (D/P) Bills:- When the documents titles of goods
accompanying a documentary bill are delivered (handed over) to the
drawee/trader/buyer after payment of the bill, it is called a D/A bill.
[Link] Bills:- When bills are drawn without accompanying any document of title of
goods to the buyer, it is called clean bills. Here, the documents will be directly sent to
the buyer.
[Link] and foreign bills:- Inland bills are those bills which are drawn upon a
person resident in India and are payable in India. Foreign bills are drawn outside
India and payable either in India or outside; otherwise it may be drawn in India but
made payable outside India. It may be drawn upon a person resident in India also.
[Link] Bills and Import Bills:- Export bills are bills which are drawn by Indian
Exporters on importers outside India and import bills are drawn on Indian importers
by exporters outside India.
[Link] Bills:-Bills which are drawn and accepted as per native custom or usage
of trade are known as indigenous bills. It is popular among indigenous bankers and
known as hundis. It is also known as shahjog /namjog /termainjog /dhanijog/
dashani/ jokhani and so on.
[Link] Bills:- Bills which does not arise out of genuine trade transactions
and drawn for mutual financial accommodation by discounting from bankers and will
be paid on due dates is known as accommodation bills. These are also called
kite/wind bills.
[Link] Bills:- Bills which are drawn by suppliers/contractors to Government
departments for the goods supplied by them. These bills are neither accepted nor
accompany any documents of title. These bills are useful only for the purpose of
getting advances from commercial banks by creating a charge on the bills.
Advantages of bills
[Link], [Link] liquidating as it has a fixed tenure and a negotiable asset, 3.
Certainty of payment, [Link] investment, [Link] legal remedy because bills
dishonoured are noted and protested and the whole amount should be debited from
the customer’s account,[Link] and quick yield, 7. Central bank control
[Link] Bill Market
A treasury bill is a promissory note issued by RBI on behalf of Government under a
discount for a period up to one year. It is purely a financial bill and not a trade bill. It
doesn’t require any ‘grading’,’ endorsement’ or ‘acceptance’ since it is a claim against
Government. The treasury bill rate (discount rate) is fixed by the RBI from time to
time. It has high degree of security and liquidity.
At present, the Government of India issues four types of treasury bills, namely, 14-
day, 91-day, 182-day and 364-day. T-bills are available for a minimum amount of Rs.
25,000 and in multiples of Rs. 25,000. T-bills are issued at a discount and are
redeemed at par. While 14-day and 91-day T-bills are auctioned every week on
Fridays, 182-day and 364-day T-bills are auctioned every alternate week on
Wednesdays. T-bills auctions are held at the Reserve Bank of India, Mumbai. (Source:
[Link]
Type of T-Bills Day of Auction Day of payment
14-day Friday following Saturday
91-day Friday following Saturday
182-day Wednesday of non-reporting week Following Thursday
364-day Wednesday of reporting week Following Thursday
(Source: [Link]
Main advantages/importance/features of T-Bills are: safety, liquidity, ideal short term
investment, ideal fund management, statutory liquidity requirement, source of short
term fund, non-inflationary monetary tool as it is redeemed at par. Its defects are:
poor yield, absence of active trading and absence of competitive bidding.
[Link] Market Instruments
In addition to the Treasury bills in the treasury market, money at call and short notice
in the call money market and commercial bills and promissory notes in the bill
market, the following new instruments are available in the money market: commercial
papers, certificate of deposits, interbank participation certificate and repo
instruments.
[Link] papers:- Commercial paper, also called CP, is a short-term debt
instrument issued by companies to raise funds generally for a time period up to one
year. It is an unsecured money market instrument issued in the form of a promissory
note and was introduced in India for the first time in 1990 as per the
recommendations of Vaghul working group. Companies that enjoy high ratings (min.
required rating is A-2) from rating agencies often use CPs to diversify their sources of
short-term borrowings. This gives investors an additional instrument. Corporates,
primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue
CP to cover short-term receivables and meet short-term financial obligations. CPs have
a minimum maturity of seven days and a maximum of up to one year from the date of
issue. They can be issued in denominations of Rs 5 lakh or multiples thereof. CPs are
usually sold at a discount to their face value, and carry higher interest rates than
bonds. Only a scheduled bank can act as an issuing and paying agent for issuance of
CP. CP can be issued either in the form of a promissory note or in a dematerialised
form through any of the depositories approved by and registered with SEBI. Banks,
FIs and PDs can hold CP only in dematerialised form.
In addition to the above other conditions for issuing CPs are:
-A corporate would be eligible to issue CP provided –
a. the tangible net worth of the company, as per the latest audited balance sheet, is
not less than Rs. 4 crore
b. company has been sanctioned working capital limit by bank/s or all-India financial
institution/s; and
c. the borrowal account of the company is classified as a Standard Asset by the
financing bank/s/ institution/s.
-Every issuer must appoint an issuing and paying agent (IPA) for issuance of CP.
- Every CP issue should be reported to the Chief General Manager, Reserve Bank of
India, Financial Markets Department, Mumbai through the Issuing and Paying Agent
(IPA) within three days from the date of completion of the issue.
[Link] of Deposit (CD):- Certificate of Deposit (CD) is a negotiable money
market instrument and issued in dematerialised form or as a Usance Promissory Note
against funds deposited at a bank or other eligible financial institution for a specified
time period. CDs can be issued by (i) scheduled commercial banks {excluding Regional
Rural Banks and Local Area Banks}; and (ii) All-India Financial Institutions (FIs) that
have been permitted by RBI. Banks have the freedom to issue CDs depending on their
funding requirements. An FI can issue CD as per the guide lines issued by RBI from
time-to-time. The minimum amount of a CD should be Rs.1 lakh. CDs can be issued
to individuals, corporations, companies (including banks and PDs), trusts, funds,
associations, [Link] maturity period of CDs issued by banks should not be less than
7 days and not more than one year, from the date of issue. The FIs can issue CDs for a
period not less than 1 year and not exceeding 3 years from the date of [Link]
have to maintain appropriate reserve requirements, i.e., cash reserve ratio (CRR) and
statutory liquidity ratio (SLR), on the issue price of the CDs. CDs in physical form are
freely transferable by endorsement and delivery. CDs in demat form can be transferred
as per the procedure applicable to other demat securities. (source:
[Link]
[Link]-Bank Term Deposit/loan:- As the name suggests, these are loan between
banks. The period of loan is over 14 days and generally up to 90 days without any
collateral security. However the lenders cannot pre-maturely recall these loans. The
DFHI, established in 1988 is the major player in the inter-bank loan market by
arranging, lending and borrowing short term funds.
[Link]-Bank Participation Certificates:- IBPCs were introduced as per the
recommendations made in 1987 by the Vaghal Committee as a revival of participation
certificate. It is an arrangement for 91 to 180 days, by which the bank issuing the
certificate show its participation as borrowings while the purchasing banks show it as
advance to other banks.
[Link] Market Mutual Funds:-In India, the RBI has introduced a scheme of
Money Market Mutual Funds (MMMFs) in April 1992. The main objective of this
scheme was to arrange an additional short term avenue for the individual investors.
This scheme has failed to receive much response as the initial guidelines were not
attractive. Thus, in November, 1995, the RBI introduced some relaxations in order to
make the scheme more attractive and flexible.
As per the existing guidelines, the banks, public financial institutions and the private
financial institutions are allowed to set up MMMFs. In the mean time, the limits of
investment in individual instruments by MMMF have already been deregulated. Since
April 1996, the RBI has allowed MMMFs to issue units to corporate enterprises and
others at par with the mutual funds introduced earlier.
The main mutual funds of the country include—Reliance MF, ICICI Prudential MF,
UTI-MF, HDFC MF and Franklin Templeton MF.
Unorganised Sector of Indian Money Market:
Unorganised segment of the Indian money market is composed of unregulated non-
bank financial intermediaries, indigenous bankers and money lenders which exist
even in the small towns and big cities. Their lending activities are mostly restricted to
small towns and villages. The persons who normally borrow from this unorganised
sector include farmers, artisans small traders and small scale producers who do not
have any access to modern banks.
The following are some of the constituents of unorganised money market in
India.
(i) Indigenous Bankers:
Indigenous bankers include those individuals and private firms which are engaged in
receiving deposits and giving loans and thereby acting like a mini bank. Their
activities are not at all regulated. During the ancient and medieval periods, these
indigenous bankers were very active. But with the growth of modern banking,
particularly after the advent of British, the business of the indigenous bankers
received a setback.
Moreover, with the growth of commercial banks and co-operative banks the area of
operations of indigenous bankers has again contracted further. Even today, a few
thousands of indigenous bankers are still operating in the western and southern parts
of the country and engaging themselves in the traditional banking business.
Indigenous bankers are classified into four main sub groups, i.e., Gujarati Shroffs,
Multani-or Shikarpuri Shroffs, Chettiars and Marwari, Kayast. Gujarati Shroffs are
mostly operating in Mumbai, Kolkata and in industrial and trading cities of Gujarat.
The Multani or Shikarpuri Shroffs are operating mainly in Mumbai and Chennai. The
Chettiars are mostly found in the South.
The Marwari Shroffs are mostly active in Mumbai, Kolkata, tea gardens of Assam and
also in different other parts of North-East India. Among the four aforesaid groups, the
Gujarati indigenous bankers are considered as the most powerful groups in respect of
its volume of business.
The indigenous bankers are mostly engaged in both banking and non-banking
business which they do not want to separate. Their lending operations remain mostly
unregulated and unsupervised. They charge high rate of interest and they are not
influenced by bank rate policy of the Reserve Bank of India.
(ii) Unregulated Non-Bank Financial Intermediaries:
There are different types of unregulated non-bank financial intermediaries in India.
They are mostly constituted by loan or finance companies, chit funds and ‘nidhis’. A
good number of finance companies in India are engaged in collecting substantial
amount of funds in the form of deposits, borrowings and other receipts.
They normally give loans to wholesale traders, retailers, artisans, and different self-
employed persons at a high rate of interest ranging between 36 to 48 per cent.
There are various types of chit funds in India. They are doing business in almost all
the states but the major portion of their business is concentrated in Tamil Nadu and
Kerala. Moreover, there are ‘nidhis’ operating in South India which are a kind of
mutual benefit funds restricted to its members.
(iii) Moneylenders:
Moneylenders are advancing loans to small borrowers like marginal and small
farmers, agricultural labourers, artisans, factory and mine workers, low paid staffs,
small traders etc. at very high rates of interest and also adopt various malpractices for
manipulating loan records of these poor borrowers.
There are broadly three types of moneylenders:
(i) Professional moneylenders dealing solely with money lending;
(ii) Itinerant moneylenders such as Kabulis and Pathans and
(iii) Non-professional moneylenders.
The area of operation of the moneylenders is very much localised and their methods of
operation is also not uniform. The money lending operation of the moneylenders is
totally unregulated and unsupervised which leads to worst exploitation of the small
borrowers.
Moneylenders have become a necessary evil in the absence of sufficient institutional
sources of credit to the poorer sections of society. Although various measures have
been introduced to control the activities of moneylenders but due to lack of political
will, these are not enforced, leading to a exploitation of small borrowers.
Reasons for the Under-Development of Indian Money Market:
Considering various defects of Indian money market it can be observed that the money
market in India is relatively underdeveloped. Moreover, in respect of resources,
rganization stability and elasticity, the said market cannot be compared with the
developed money markets of London and New York. But among the third world
countries India has been maintaining the most developed banking system. Even then
the rganization of the money market is still underdeveloped.
The underdevelopment nature of Indian money market is mostly determined by the
following shortcomings:
-Firstly, Indian money market fails to possess an adequate and continuous supply of
short term assets such as treasury bills, bills of exchange, short term Government
bonds etc.
-Secondly, this market is lacking the highly organised banking system, so important
for the successful working of a money market.
-Thirdly, the sub-markets like acceptance market and the commercial bill market are
non-existent in Indian money market.
-Fourthly, Indian money market has totally failed to develop market for short term
assets and accordingly there are no dealers of short term assets who act as
intermediaries between the Government and the entire banking system.
-Fifthly, Indian money market in suffering from lack of co-ordination between its
different constituents.
-Sixthly, Indian money market again fails to attract any foreign funds.
-Finally, Indian money market cannot be termed as a developed one considering its
supply of fund and the liquidity position
Measures to Reform and Strengthen Indian Money Market:
In recent years, serious efforts have been made by the Government and the RBI to
remove the shortcomings of Indian money market. RBI, in the mean time has reduced
considerably the differences between the various constituents of money market.
Differences in the interest rates have also been reduced by the RBI and the monetary
stringency has also been reduced by the RBI through open market operations and bill
market scheme.
Even then, Indian money market is still very much dependent on the call money
market which is again characterised by high volatility. In the mean time, the RBI has
introduced various measures to reform the money market as per recommendations of
the Sukhamoy Chakraborty Committee on the “Review of the working of the Monetary
system” and the Narasimham Committee report on the working of the Financial
System in India.
Following are some of the important reform measures introduced to strengthen
the Indian money market:
(i) Remission of Stamp Duty:
In order to remove the major administrative constraint in the use of bill system, the
Government has remitted the stamp duty in August 1989. However, the experts feel
that unless the cash credit system is discouraged this government decision to remit
the stump duty is not going to favour the prevailing bill system.
(ii) Deregulation of Interest Rates:
Another important step to strengthen the money market was to deregulate the money
market interest rates since May, 1989. This will bring interest rate flexibility and
transparency in money market transactions.
Again in November, [Link] per the recommendations of the Narasimham Committee,
the interest rates have been further deregulated and the banks and other financial
institutions have been advised to determine and adopt market related rates of interest
as far as practicable.
(iii) Introduction of New Instruments:
The RBI has introduced certain money market instruments for strengthening the
market conditions. These instruments are—182 days treasury bills, longer maturity
treasury bills, Certificates of Deposits (CDs), Commercial Paper (CP) and dated
Government securities.
Discount and Finance House of India (DFHI) promoted the 182-day treasury bills
systematically and these bills were the first security sold by auction for financing the
fiscal deficit of the Central Government. Again, the DFHI has also developed a
secondary market in these bills and they become popular with the commercial banks.
Again in 1992-93, the Government decided to introduce 364 day treasury bills and
discontinued the 164-day treasury bills. The 364 day treasury bills can be held by
commercial banks for meeting its statutory liquidity ratio. CDs received a considerable
market during 1995-96.
The volume of outstanding CDs gradually rose from Rs 6,385 crore in January 1995 to
Rs 20,815 crore on July 5, 1996. CPs are another instrument which made
considerable progress in 1992-93 and 1993-94. Outstanding amount of CPs increased
from Rs 64.70 crore in June 1991 to Rs 3,264 crore in March 1994. Again the activity
of CP market declined sharply in 1995-96 and thereby the outstanding CPs as on April
30. 1996 was only Rs 71.3 crore.
(iv) DFHI:
The Discount and Finance House of India (DFHI) was set up on April 25, 1988 as a
part of the reform package for strengthening money market. The main function of
DFHI is to bring the entire financial system consisting of the scheduled commercial
banks, co-operative banks, foreign banks and all- India financial institutions, both in
the public and private sector, within the fold of the Indian money market.
This House will normally buy bills and short term papers from different banks and
financial institutions in order to invest all of their idle funds for short periods. DFHI
has also started to buy and sell government securities from April 1992 in limited
quantity with the necessary refinance support from the RBI.
(v) Money Market Mutual Funds (MMMFs):
The Government announced the establishment of Money Market Mutual Funds
(MMMFs) in April 1992 with the sole objective to bring money market instruments
within the reach of individuals. The MMMFs have been set up by different scheduled
commercial banks and public financial institutions.
The shares or units of MMMFs have been issued only to individuals. Thus the
aforesaid measures to reform Indian money market have helped it to become more
advanced, solvent and vibrant. With the introduction of new instruments, the
secondary market has also developed considerably.
Moreover, with the setting up of DFHI and MMMFs, the lot of Indian money market
has achieved considerable progress in recent rimes and is also expected to achieve
further progress in the years to come.
PRIMARY MARKET/NEW ISSUE MARKET (NIM)